Following the “great recession” of 2008 – 2009, the United States economy has slowly but steadily recovered. Much of this has been propelled by the deft management of quantitative easing (QE) by the U.S. Federal Reserve Bank. As the U.S. contributes over 19% of the world’s gross domestic product (GDP), its health is paramount to creating a positive climate for investing. Following an anemic GDP growth rate of 1.7% in 2011, the rate of growth has improved to about 2.0% (annualized) during 2012, a rate that is expected to be sustained in 2013.
Against this backdrop, the U.S. stock market has performed well over the past two years. The S&P 500 Index has recovered to its highest level since 2007. During this period, the U.S. market has outperformed Canada’s, a reversal of the previous decade. Canada’s resource heavy stock market has struggled lately, in response to a slowdown in Chinese economic growth.
While the climate has improved in the United States, it is far from perfect. Unemployment has remained stubbornly high, at 8.1%. Interestingly, there has been strong job creation in the private sector, with 415,000 net new jobs added since early 2009. This has been more than offset by the loss of 700,000 government jobs at the state and local level. The best area for new job creation has been California, where 365,000 new jobs were added in the first half of this year.
The U.S. housing market is beginning to recover from its dramatic crash in 2008. As excess inventories become absorbed, prices have firmed modestly, and some new construction is appearing. Another key industry in the U.S., autos, has rebounded nicely. U.S. consumers have been making a concerted effort to pay down their debt, with savings rates now at their highest since the early 1970’s. With credit card debt increasingly under control, there are signs that mortgage debt is also beginning to be tamed.
There is a worrying element on the immediate horizon. With election season in full force, the politicians in Washington have delayed dealing with an issue known as the “fiscal cliff”. This refers to the scheduled expiration of tax cuts from the Bush era, along with government spending cuts that were negotiated last year. Should these cuts be allowed to expire on December 31st, this could reduce U.S. GDP by up to 5%, sending the country back into recession. In detail, if the tax cuts expire, long-term capital gains rates will increase from 15% to 23.8% and marginal income tax rates will climb from 35% to 43.4%. This would result in a total tax increase of $536 billion in 2013, money that wouldn’t be available to help sustain the recovery. Following the U.S. elections on November 6th, the Democrats and Republicans will have about six weeks to negotiate the terms of an effective delay to these cuts. We believe that they will come to an agreement, although it will likely involve some last minute brinkmanship.
Over the past year, we have gradually increased the weighting of U.S. stocks in your portfolios. We own U.S. companies that have a truly global scope to their businesses, generate growing cash flow from operations, and allocate free cash flow in a manner that is attractive to shareholders. We will continue to monitor our holdings of these companies and seek new ones that fit this profile.